For the fourth time I'm reading Fiat Money Inflation in France. This book details the fall of France in the 1800s due to it's failed monetary policies which were caused when they abandonded gold backed currency. I am struck by the similarity of what was being said by the pundits of their day and what is being said by our modern-day pundits.
Their crisis was blamed on all the same culprits of today - mostly greedy investors and lenders. Greed in general as a motivating factor is often blamed but in reality people make decisions they perceive to be in their self-interest. It's only in retrospect the blame-placers come along and it's always the greed of others that they finger.
Our current Secretary of the Treasury, Henry Paulson blames bad lending practices. This seems like a plausible explanation but how could that be? Lenders are regulated to the Nth degree. Currently there are 317 regulations they must comply with and loan recipients had to fall within strict Fannie Mae or HUD guidelines.
While subprime loans and fraud play a role, they are not the main culprits. Lenders use risk-assessment to evaluate the credit worthiness of their applicants but even subprime and stated income applicants received loans based upon the liberal policies of the federal government. It was the government whose policies led to an abundance of money to loan out and lenders were only too happy to comply. Why? Because they perceived it was in their best self-interest.
Through various mechanisms the Fed can contract or expand the money supply. This is the history of fiat money (created out of thin air). The money supply is always expanded. So it was the lending practices dictated by our federal government predicated on ever-higher housing prices that created our crises. Given the abundance of money, this expectation was not unrealistic.
We enabled the Fed to artificially control the supply of money long ago when we abandoned currency backed by gold. Once politicians understand they can spend more than they bring in simply by expanding the money supply, the supply of money will inevitably increase. It increases both to pay for the things they've promised and to create an artificial stimulus to make it seem like our economy is vibrant and growing. In reality though there is a displacement of wealth. This displacement travels from people who in previous generations embraced the art of thrift to those who now speculate. That is exactly what has been happening in real estate for many years.
It's very simple. If you have a $1000 in a bank account and the Fed suddenly increases the money supply by 26% (which is what they did between 2001-2005) then effectively the purchasing power of your $1000 went to $740. Yet had you decided to speculate and invest your $1000 in something with a limited and unchanging supply (real estate for example) it's likely your $1000 would have at least remained on par with the increase in money supply and thus increase in value to $1260.
Correctly, you often hear that real estate is a good hedge against inflation. So why did the real estate bubble pop? It has to do with the word "correction". Our continuing expansion of the money supply has created a nation of speculators - speculators in the stock market and real estate. People correctly ascertained that saving is foolhardy. It's in their best interest to put their money where it will be leveraged and exceed the rate of inflation. Sooner or later though there's got to be a correction. Real estate prices increased at twice the inflation rate for 10 years prior to our current problems.
Banks made loans based upon the assumption that real estate prices would continue to increase. Homebuyers properly assessing the situation have begun to realize they are making payments on properties now valued far below the mortgages they owe on them.
The agreement homeowners have with their banks is that the bank can have the house back should they stop making the payments and this was a rational response to the decline in the value of homes.
When investors who purchased mortgage backed securities started to realize that the collateral of the homes which backed their securities was no longer enough to cover their investment, another crises ensued - the mortgage backed security crises and the insurance companies that back these securities. There has been a ripple effect that has affected the stock market and consumer confidence.
What does all this mean to the average homeowner? We're in the midst of a correction. Understand this and you can position yourself to weather the storm and even take advantage of the circumstances. The actions you take will depend upon your personal circumstances and real estate can play a major role in becoming financially free.
Excluding a total collapse of the market, I believe home prices have leveled off. There's never been a better time to buy a home. Interest rates are still very low and you can find bargains galore.
Though we have considerably more home inventory now than three years ago, the number of transactions is greater than three years ago. People continue to need housing and they are taking advantage of the bargains in the market place. If you're a seller that means you may have to take less for your home than you had anticipated. If however you're also a buyer, one who is upgrading, the hit you'll take on your existing home will be more than compensated for by the savings you'll realize in the purchase of a new home.
For example, if the market value on your $250K home has dropped by 10%, you'll sell it for $25K less than a few years ago. Here's the key though. If you're buying a new $400K home at a 10% discount, you're saving $40K. That means you're still better off by $15K.
What is the overall arching lesson to be learned then? First off, people act in their own rational self-interest and that's perfectly OK, as long as their actions aren't coercive. This is exactly what buyers, investors and lenders have been doing since the beginning of time. Secondly we must be astute observers of the signs of the times and as much as possible position ourselves to benefit from an uncertain market.
The fact that we ever gave government the power to artificially manipulate the supply of money is a curse upon us. We have, in fact, placed our trust on the government above our trust in the free market. It's as if we could somehow thwart the law of gravity and expect it to obey us. The result is the arbitrary and unjust displacement of wealth. By any other name this practice is called stealing. It's coercive, evil, penalizes thrift, rewards speculation and is simply wrong, wrong, wrong. The blame for our current economic crises then must be squarely placed upon the shoulders of government and even more upon us for placing our trust in the workings of men rather than the (God-ordained) free-market.
Comments(1)